Summary
Summary Financial & Managerial Accounting, ISBN: 9781119391609 Accounting
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A summary of the Financial Accounting part of the Accounting course of IBA.
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Week 1 – Chapter 1,2,3,4The three steps in the accounting process are identification, recording, and communication.
Accounting is information to all kind of actions, decisions, results, transactions into figures to steer
the business and inform stakeholders.
Organization = accounting information systems; recording, storing, processing, reporting
Specification of contents = accounting (of annual accounts, tax filing etc.)
Verification and assurance = auditing
Financial Accounting: external financial reporting and bookkeeping (for stakeholders)
Management Accounting: internal information for decision-making, performance evaluation, control.
The basic accounting equation – Assets = Liabilities + Stockholders’ Equity
Expanded accounting equation - Assets = Liabilities + Common stock + Revenues – Expenses –
Dividends
FINANCIAL ACCOUNTING: THREE STATEMENTS
- Balance sheet: overview of the firm’s situation at a point in time
Assets: what the firm owns; what it has done with the funds it received
Liabilities: what the firm owes (to creditors; all the persons/entities they owe money to); where the
funds came from. Accounts payable = purchases on credit. Note payable = borrowed money (bank).
Split into equity (funds from owners) and other liabilities.
Equity: The ownership claim on a corporation’s total assets is stockholders’ equity. It consists of
common stock (the total amount paid in by stockholders for the shares they purchase) and retained
earnings (defined by revenues, expenses and dividends (not an expense)). So EQUITY is the value for
the OWNERS (Stockholders, shareholders). So if you earn money as a firm, EQUITY increases.
There is a balance Assets (left) = Liabilities (right)
- Profit and loss statement: the results of a company over a period of time
- Cash flow statement: the flow of money into and out of the company over a period of time
The changes in Cash and Equity are visible in the separate statements, respectively, the cash flow and
the income statement. SO changes in other assets and liabilities correct for the fact that not all value
changes are identical to cash flow changes!
BALANCE SHEET: (cash flow = Δ cash; Profit/loss = Δ equity)
Δ cash + Δ other assets = Δ liabilities + Δ equity
Rewrite: profit = cash flow + “accruals”
Accruals: the difference between cash flow and profit
In a balance sheet the years are from most current year to working back 2018, 2017, 2016
“Revenues” in the income statement are:
- cash receipts, or
- increases in other assets, or
- decreases in liabilities
“Expenses” in income statement are:
- cash expenditures, or
- decreases in other assets, or
- increases in liabilities
, Difference between expenditures and expenses: an expense recognizes the consumption of a cost,
while an expenditure represents the disbursement of funds
Profit that the firm makes is for the owners. If the owners leave it in the company, equity increases.
This is referred to as ‘retained earnings’. So earnings do not have to be retained in the firm; if a firm
pays dividends, these ‘are part of the profit the firm made’.
Δ cash + Δ other assets = Δ liabilities + Δ equity
cash flow + Δ other assets = Δ liabilities + profit + share issues – dividends
profit = cash flow + (Δ other assets - Δ liabilities) – share issues + dividends
profit = cash flow + “accruals” – net funds contributed by shareholders
Chapter 1
The historical cost principle (or cost principle) dictates that companies record assets at their cost. This
is true not only at the time the asset is purchased but also over the time the asset is held.
The fair value principle states that assets and liabilities should be reported at fair value (the price
received to sell an asset or settle a liability).
The monetary unit assumption requires that companies include in the accounting records only
transaction data that can be expressed in money terms. This assumption enables accounting to
quantify (measure) economic events. The monetary unit assumption is vital to applying the historical
cost principle. This assumption prevents the inclusion of some relevant information in the accounting
records.
The economic entity assumption requires that the activities of the entity be kept separate and distinct
from the activities of its owner and all other economic entities.
A business owned by one person is generally a proprietorship. Usually, only a relatively small amount
of money (capital) is necessary to start in business as a proprietorship. The owner (proprietor)
receives any profits, suffers any losses, and is personally liable for all debts of the business.
A business owned by two or more persons associated as partners is a partnership. Like a
proprietorship, for accounting purposes the partnership transactions must be kept separate from the
personal activities of the partners.
A business organized as a separate legal entity under state corporation law and having ownership
divided into transferable shares of stock is a corporation. The holders of the shares (stockholders)
enjoy limited liability. Stockholders may transfer all or part of their ownership shares to other
investors at any time.
The accounting cycle graphic:
Journalize trial balance adjusting entries adjusted trial balance financial statements
closing entries post-closing trial balance
Transactions (business transactions) are a business’s economic events recorded by accoun- tants.
Transactions may be external or internal. External transactions involve economic events between the
company and some outside enterprise. Internal transactions are economic events that occur entirely
within one company.
1. Each transaction must be analyzed in terms of its effect on:
a. The three components of the basic accounting equation (assets, liabilities, and stock
holders’ equity).
b. Specific types (kinds) of items within each component (such as the asset Cash).
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